| How to Profit From Deflation - Part One |
| Tuesday, 14 April 2009 14:35 | ||||||||||||||||||||||||||
This article was originally published November 21st, 2008 as the deflation scare in the U.S. was beginning to acquire some traction. Since that time the major central banks around the world have gone to extreme measures to fight deflation and its negative economic effects. It has now been 6 months since that initial scare and today's PPI numbers continued a trend of negative inflation measures. Today's PPI number was the 5th in 7 months to show negative producer price growth. 
As central banks in Europe and the U.S. continue to fight deflation I think it is useful to talk about what deflation is and how it is possible to profit from it. Although deflation can be extremely disruptive to an economy it has happened before and if you know what to look for it may be the source of opportunity rather than hazards. Four of the major symptoms of deflation are; 1. A trend towards lower consumer, commodity and producer prices 2. Falling consumer demand and spending with increased savings rates 3. A tighter credit market 4. Negative risk adjusted rates of return (have you checked your 401K lately?) Ultimately deflation represents a shift from spending and investing to interest and savings. You can judge for yourself whether we are seeing the signs of deflation in the US and European economies or not. The reduced aggregate demand in the economy ultimately reduces prices, which increases buying power or "deflates" the currency. In this situation, savers benefit because the value of cash and cash equivalents increases. Borrowers suffer as the money they spend on debt service and interest costs them more. Deflation is like a tax credit on savings and a penalty on interest. One of the reasons deflation is feared from an economic perspective is because so much growth is funded by debt and leverage. If debt becomes cost prohibitive and investors are unwilling to take larger risks then companies built for an inflationary economy can't grow like they have in the past. This is bad for most stocks. In the video I will show an example for why deflation would hurt even strong stocks like AAPL should it continue to spiral. However, despite the risks, deflation is not necessarily all bad if you have prepared your portfolio for it. In the next few sections in this series I will walk through some of the things savvy investors should consider if deflation starts to take a real hold on the economy. Another side benefit of the current economic trend is that we have a great deal of information from the Fed's management team about how they would deal with deflation should it occur. This can provide a certain amount of prescience for managing your portfolio. For example, here is an excellent article written by Ben Bernanke, before he was the Fed chairman, about deflation and how he suggests the fed should deal with it. It is an interesting read now that we have seen what he has done so far as Fed Chairman to fight deflation over the last 6 months.
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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved." |
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